How to Protect Yourself from HELOC Disaster

Sometimes, something that you think is safe can turn into something quite dangerous. Like golfing, one of the safest sports known to man. Or is it? A golfer in California recently hit a routine stroke. The ball hit a rock and actually started a fire, which enflamed 25 acres and required 150 firefighters to tame it. While a home equity line of credit (HELOC) seems potentially less harmful than a golf ball, the results could also be explosive if you use it incorrectly. Here are four ways to avoid being burned by your HELOC.

A HELOC’s adjustable rate

One of the advantages of a HELOC – an adjustable rate – can quickly evolve into one of the largest disadvantages. If interest rates start rising, your monthly payments will increase along with it. In high-interest rate environments, this can happen quickly and steadily, and suddenly present you with monthly payments that are out of your comfort zone. Also, some lenders offer promotional rates for six-months to a year. If that’s the type of loan you’re considering, make sure you’re prepared for the increased payments once the promotional period ends.

The interest only trap

Another great thing about HELOCs is that each month, you’re generally able to make interest payments only. But if you don’t start paying your principal, you may be shocked by the mandatory balloon payment that’s due when your HELOC ends. Protect yourself from this bursting balloon by preparing for a mortgage refinance well in advance of your due date. Better yet, be disciplined throughout the course of your HELOC by making regular payments of principal, even though it’s not required. Work a monthly principal payment into each month’s budget, or pay your principal down from the proceeds of a work bonus or tax refund when you’re lucky enough to get one.

Hidden fees

Some lenders charge annual fees on HELOCs. Does yours? Best to find out before you enter into an agreement, or you may end up paying interest on that for the life of the loan.

Credit line freeze

If you count on your HELOC for an emergency fund, it may come as a shock if your bank decides to freeze your line of credit. This can happen if one of three events occur:

1.    The equity in your home is reduced by 50 percent from the time you took out your loan
2.    You’re delinquent in your monthly payments
3.    A significant change occurs in your financial circumstances

It’s a hassle getting it reinstated, so the best defense is a good offense. You can’t do much about numbers 1 and 3, but you certainly can make sure that number 2 never occurs.

Luckily for the golfer, no one was hurt in the fire described above. But if your HELOC goes up in flames, you could wind up with some serious financial problems and potentially lose your home.

Tags: adjustable rate, HELOC